We maintain OVERWEIGHT on the sector. For mobile players, we believe stock valuations and sentiment will recover once the government announces the 5G Dual Network policy directive. Following this, lingering concerns about earnings, capex, and dividends is expected to finally resolve. Meanwhile, for fixed line operators, we anticipate earnings boost, driven by the ongoing influx of investments in data center (DC), cloud and AI infrastructure in Malaysia. This growth is supported by increasing demand for managed wavelength and wholesale bandwidth services, which enable data transmission between DCs and public or private cloud infrastructure, as well as between hyperscale DC to DC. Our sector top pick is TM (OP; TP: RM7.53).

1. Mobile

Judgement day soon, as early as 4QCY24. In the mobile segment, the government may finally unveil the official 5G Dual Network (DN) policy directive in 4QCY24. Thus, this may reveal the equity stake for each mobile player in either entity A or B. To recap, the said entities will be set up to facilitate Malaysia’s transition from the 5G Single Wholesale Network model to DN. Entity A will take over the existing first 5G network (NW1) owned by Digital Nasional Berhad (DNB), whilst B will develop the new second 5G network (NW2) from scratch. Both entities will be entirely owned by private telcos, which will likely include CDB (OP; TP: RM5.59), MAXIS (MP; TP: RM3.74), YTLPOWR (OP; TP: RM5.20) and U Mobile Sdn Bhd). With the exception of TM, the four players now own a cumulative stake of 65.1% in DNB after completion of a due diligence exercise, share sale agreement (SSA) and conditional SSA with the Ministry of Finance (MoF) and DNB in end June 2024.

Recovery in valuations after air is cleared. Given immense uncertainty surrounding 5GDN, we believe stock valuations and sentiment for MNOs will recover once the government announces the official policy directive. Hence, this will finally alleviate concerns about earnings, capex, and dividends that have weighed on the sector. While the actual mechanism remains uncertain at this juncture, please refer to our scenario analysis below for the possible outcomes. Recall that it is the government’s aspiration for healthy competition to drive enhanced 5G coverage and service quality. Therefore, we postulate that entities A and B will each be spearheaded by a single major telco leading a consortium of other smaller players. Additionally, there should not be a significant disparity between the collective subscriber base of the telco owners in each entity. Hence, one does not have an unfair advantage over the other and 5G traffic would be evenly distributed between both networks. Additionally, we believe that operating conditions need to be level – which implies equal ownership of 5G spectrum blocks between A & B.

Entity A may be compensated. Recall that the government revealed that entity B has two years to progressively reach 80% population coverage. If this term prevails, we believe that B’s shareholders will continue to pay for 5G access from A during the initial stage. As such, they may continue to offer 5G services until B’s network achieves sufficient capacity. Recall that DNB imposed target capacity payment of RM360m p.a. on MAXIS, and RM288m p.a. for other access seekers under a long-term 10- year agreement. However, when B’s network is finally launched, this agreement may be revised or prematurely terminated. Therefore, it is possible that A may be unable to fully recoup its investments on NW1. As such, we do not discount the possibility that B’s shareholders may need to provide financial compensation to A for early termination of its access agreement.

Two sides to every coin. In our view, assuming no major cash outlay upfront, there are pros and cons to participating in either entity A or B. We believe that the telco that controls entity B may optimize roll-out of NW2 to integrate with its existing core network and tower portfolio. Autonomy over selection of its key technology provider, suppliers, and vendors implies better control over expenses and roll-out strategy. In turn, this results in better service quality and higher asset returns. Furthermore, B’s network quality may turn out to be more superior given brand new equipment based on more advanced 5.5G technology. On the flipside, entity B needs to allocate resources, especially manpower and fundraising efforts, to roll out a new network.

So much uncertainty on A. In comparison, control of entity A implies immediate cash flows accretion from access payments on NW1. However, its legacy cost structure and fixed design may be a potential setback. Hence, this may diminish its competitive edge in securing off-take from price sensitive access seekers. Recall that regulated tariffs offered by B cannot exceed that of NW1. Hence, if given a more efficient cost structure, B may potentially offer lower rates and snag wholesale market share from A.

B is more straight cut. In our opinion, for entity A shareholders, the best-case scenario is that associate contribution from A more than offsets costs for: (i) network access payments, and (ii) opportunity and/or interest costs on initial cash outlay. These same benefits may also apply to Entity B post completion of NW2. Conversely, the worst-case scenario for A’s owners may manifest as: (i) significant associate losses from A, (ii) substantial 5G access payments drag on EBITDA margins, and (iii) sizable cash outlay required to secure a stake in A. In turn, this would lead to: (i) contraction in profit and cash flow, and (ii) lowered dividend payout as EBITDA declines.

Competitive prepaid market remains challenging. In terms of mobile market indicators, we believe that prepaid ARPUs will remain largely stable in 4QCY24. This is premised on our belief that major mobile network operators (MNO) are reluctant to engage in intense price wars with mobile virtual network operators (MVNO). To recap, prepaid ARPUs appear to have stabilized in 2QFY24, as it remained constant QoQ for Celcom and MAXIS, but inched up slightly for Digi on sequential basis. In our view, competition would rationalize as the major players scale back on their aggressive strategy to protect against further ARPU erosion, and focus on the postpaid segment instead. As a result, we anticipate MNOs will experience subscriber churn in the near-to-medium term, given that prepaid users are typically price sensitive.

Unrelenting traction in postpaid subscriber momentum. After a sharp decline since 2022, we expect postpaid ARPUs to stabilize or experience a slight dip in the upcoming quarters. This will likely be driven by the sustained popularity of affordable entry-level postpaid plans, which tend to attract lower-ARPU users and encourage pre-to-postpaid migration. On the back of this, and coupled with ongoing efforts to promote convergence plans, we expect the MNOs to maintain healthy postpaid net adds momentum. This builds on the strong traction seen in 2QFY24, where both CDB and MAXIS achieved robust net adds of 118k and 96k, respectively. Notably, CDB’s QoQ postpaid net adds snowballed from 20k in 4QFY22 to 118k in 2QFY24, possibly reflecting its effective post-merger marketing strategies.

2. Fixed

Competition brewing in the home fiber market. For the fixed line segment, we expect competitive headwinds will linger in 4QCY24, as MNOs ramp up efforts to attract subscribers for their convergence packages. This follows the trend seen in 2QCY24, where market leader, Unifi reported sequential ARPU decline due to promotional discounts and an influx of new subscribers on entry-level plans. On the bright side, the consumer fiber marker continued to expand in 2QCY24, as net adds for TM and the MNOs inched up sequentially. However, this was likely driven by attractive below-the-line discounts from CDB and TM. Looking ahead to 4QCY24, we anticipate sustained pressure on home fiber ARPUs, a slowdown in TM’s net adds, and further market share gains by the MNOs.

AI data centers driving data transmission volumes. Moving forward, we believe fixed line operators will benefit from the ongoing influx of investments in data center (DC), cloud and AI infrastructure in Malaysia. To recap, in recent months, US tech giants, namely AWS, Microsoft, and Google announced Malaysian investments exceeding USD10b in these areas. Additionally, new hyperscale DCs in Johor are emerging, driven by international co-location (co-lo) operators such as AirTrunk, ST Telemedia, K2 Strategic, Princeton Digital Group, Equinix, Yondr, among others. According to DC Byte, Johor’s current DC capacity stands at c.1,600MW, at various stages of development, comprising: (i) live: 12%, (ii) under construction: 8%, (iii) committed: 29%, and (iv) early stage: 49%. As a result, Malaysia’s total DC capacity is forecast to surge more than 11-fold from 280MW in 1QCY24 to c. 3.2GW by 2028F. We believe this growth is underpinned by increasing demand for storage and compute capacity, particularly for training foundation models or large language models powered by generative AI.

Growing demand for wholesale bandwidth and managed wavelength. Against this backdrop, we anticipate growing demand for managed wavelength and wholesale bandwidth services (e.g. hot standby bandwidth allocation (HSBA), and indefeasible right of use (IRU) contracts) to facilitate data transmission between hyperscale DC to DC, as well as between DCs and public or private cloud infrastructure. This would require digital infrastructure owned by fixed line operators, including terrestrial fiber optics backhaul, network hubs, and submarine cables with landing stations. On the back of this, TM recently revealed that it has established managed wavelength services for global hyperscale DCs and content providers. Additionally, the upcoming completion of the SEA-ME-WE 6 submarine cable system is expected to meet rising demand from new DCs in Malaysia. To recap, TM is part of a consortium for the 21,700 km Southeast Asia - Middle East - Western Europe 6 (SEA-ME-WE 6) submarine cable system. It has a capacity of 100 Tbps and connects France and Singapore, with 17 landing points across 15 countries.

3. Summary

Favor fixed players. We prefer fixed line operators given lingering uncertainty on MNOs pending the announcement of the 5G 5GDN policy. In the near-to-medium term, we are closely monitoring earnings traction from managed wavelength and global bandwidth connectivity services for current and upcoming DCs in Malaysia. Additionally, we are also hopeful that sentiment recovers if the 5G DN policy yields better-than-expected outcomes, specifically in terms of: (i) opex: fair 5G access fees for NW1 and adequate compensation for early termination of NW1 access agreement, (ii) dividends: no capex spike as NW2’s rollout timeline and coverage targets are reasonable, (iii) balance sheet: NW1 does not have excessive debt and payables, and (iv) profit & cashflows: NW1 is profitable and cash generative in the medium-to-long run.

We maintain our OVERWEIGHT recommendation on the sector with TM as our top pick. We like TM on account of: (i) it being leveraged towards secular data growth on the back of current trends such as digital transformation, proliferation of internet of things (IoT), cloud services powered by generative AI, etc, (ii) it benefitting from upcoming JENDELA phase 2 projects via rollout and monetization opportunities, and (iii) earnings accretion from development of new hyperscale data center, and (iv) higher demand for data transmission via its network of digital infrastructure that includes submarine cables and landings, as well as terrestrial fiber optics backhaul.

Source: Kenanga Research - 2 Oct 2024